As NFT was the 2021 word, I believe that if not the word of the year, tokenization should be one of the most important words in 2023.
Tokenization is the process of digitalization of real world into a digital asset, such as a real estate asset located, for example in Tulum, México. But, why would someone would like to tokenize a physical asset?
There are plenty of advantages that tokenization have, among others we can find the following:
– The possibility of having a worldwide access to large and small investors. And when saying small, I mean small but in large numbers. So a new possibility for small investors to access these type of real estate investments is a reality.
Before this, the only way to invest in real estate for small investors were the REITs (which are basically investments in real estate assets that were accessible only through the stock market). This brings a lot more liquidity to investments because even without a bank account, you can access to this type of investment.
– A much more safe investment. Since tokenization is based on the Blockchain, an investor have access to every piece of information about the real asset, including, pricing history, former owners of the real estate, regardless of the formal and eternal process that the property should be subject in Mexico. This is an advantage, because frauds are common in the real estate field in Mexico. Public registry is as slow as a sloth.
– The process of acquiring the tokens or the property is substantially more efficient than acquiring a physical real estate in Mexico, and of course, a long list of intermediaries gets out of the picture. So, it is a much more efficient way of doing business.
– There is a 24/7 open market, since you can sell your token at any time, any day, instead of waiting until the notary public in Mexico could give you an appointment and align the stars for the seller, the real estate agent, and the buyer to meet and do all formalities.
– Rents or dividends could be automatically paid through a smart contract and no human intervention is needed for that, so it is a more efficient way of paying profits.
After reading this, many real estate players could be thinking of how wonderful would be to tokenize their real estate assets, but they should first make several choices such as the Blockchain they are going to use (for example Ethereum), the type of token they are issuing, the rights of such tokens, if they are going to tokenize real estate, or the rights on a company that owns the real estate, or the rights of debt linked with the real estate, among many other important choices.
One of the less analyzed inputs of these type of projects is the legal and tax; but a mistake in this field could represent a financial death sentence before the project is even born. Why?
Among other reasons, two important come to my mind: 1. If the issuance of the token is considered as the offering of a security for legal purposes and no authorization is obtained from financial authorities, in an extreme case, criminal penalties could exists in certain countries (for example, Mexico); and 2. If the corporate and tax structuring ARE not adequately designed, all income received by the project on the sale of the tokens could be deemed as income attributable to the founders at an incredibly high tax rate (and thus, starting the project with a tax contingency at a personal level of founders) or withholding tax obligations are triggered in the country in which the assets are physically located (i.e. real estate or shares with more than 50% of its equity value linked to real estate located in such country), every time a token is transferred either by the project or by the token holders.
Entrepreneurs who are structuring tokenization projects must start considering more seriously the legal and tax inputs in their projects, since almost all of the international projects that my eyes have seen lack of these professional design, and as mentioned, these factors could be project killing.
My intention is not to generate fear within the crypto enthusiastic community, but to remind that when designing this type of projects, legal and tax issues are as important as commercial or technological inputs.